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Is your business underpaying its most vital employee (you)?

A small business owner working in his woodshop.

As a small business owner thinking about business expenses, personal salaries are easy to overlook. In fact, a 2017 survey revealed that slightly over 50 percent of small business owners either don’t pay themselves at all or take home a very modest salary, well below that of their employees.

This typically happens when they feel that their business doesn’t earn enough to justify their own salary, their client load changes so they simply pay what they can when they can, and when times are tough, they pay vendors, utilities, and rent before they think to take home their own paycheck. In short, business owners tend to make personal salary cuts from a place of stress or in an effort to reinvest in their business and help drive its growth.

Why does owner compensation matter?

While it may seem like a logical call in the moment, small business owners skimping on their own salaries can come back to haunt them. If you’re not setting aside funds for your own salary, your books won’t accurately reflect the financial health of your company. Without taking all expenses into account, you won’t know if you need to make any adjustments like cutting costs or increasing prices. And not to mention, having adequate cash flow is vital for any business. It’s far easier to manage cash flow when you have predictable expenses you can plan around. This includes your salary.

Most importantly, you’re still a hardworking individual who deserves adequate compensation in exchange for your time and labor. But there’s also a pragmatic reason to pay yourself. Depending on the structure of your company, it’s possible to get a tax break if you set aside a personal salary out of your total business income. Delaney Tax & Wealth Management founder Whitney Delaney explains, “Let’s say you’re making a net income of $100,000 a year in your business, and you file as a sole proprietor: Self-employment tax – which consists of Social Security and Medicare–will be calculated from the full $100,000. On the other hand, if you’re an S corporation and you pay yourself a salary, your [deductions] will be based [only] on your salary rather than your total net revenue.”

Moreover, it should be acknowledged that depriving oneself of a salary can also add to financial stress which can ultimately negatively impact business decision making. Plus, paying yourself as a business owner is not just about the money, it’s also about preventing burnout and preserving your mental health. It’s critical that you are being compensated for the tireless effort and energy you pour into your business. And, it can serve as an effective motivator. When you receive compensation, it becomes easier to reinvest yourself back into your business.

If paying yourself a salary puts too much stress on your business, this is a good opportunity to look for inefficiencies and to make adjustments that will free up some extra cash for you to take home.

How to pay yourself

So now the question becomes, how do you pay yourself? And how much? It goes without saying that you need to make enough money to cover your basic living expenses. You don’t want to be stressed about your finances when having to make big business decisions. On the other hand, you don’t want to pay yourself too large a salary and drain your business’s cash flow.

A good place to start is by asking yourself what your labor is worth. In other words, what would you be paid at a similar company? To keep fleshing your salary out, check out the following five tips that business experts Delaney, Bredin, and Singer came up with to help when deciding on small business owner compensation:

  1. If your business is established and profitable, pay yourself a regular salary equal to a percentage of your average monthly profit.
  2. Don’t set your monthly salary to an amount that may stress your company’s finances at any point.
  3. Consider changing your tax treatment or organization type to an S corporation to reduce your self-employment tax liability.
  4. Take other profit distributions regularly, but only when those distributions won’t be a burden for the business.
  5. Periodically review your salary as part of your overall compensation and adjust it up or down based on the business’s revenue and cash needs.

If you have an accountant and want an outside opinion, you can run your final number by them to find out if they think that this sum is appropriate or if it misses the mark.

Final thoughts

Ready to calculate your personal salary? You now have the tools necessary to give yourself the wonderful feeling that comes along with seeing your hard work turn into a well-earned paycheck!

*This blog post is intended for informational purposes only and is not intended as financial advice.
**Melio does not provide legal, tax or accounting advice, and you should consult with a professional advisor before making any financial decisions.